ETHIOPIA & PRESIDENTIAL ADVISOR
0356 RTZ Tax
[This letter was my response to
Seeye Abraha about the tax and royalties payable by RTZ. It also, though, is a
good summary of the graft that comes about in many African countries!]
STRICTLY
CONFIDENTIAL
Seeye Abraha
Minister of Defence
Addis Abeba
Dear Minister,
RTZ - RESPONSE TO TAX/ROYALTIES PACKAGE 5 October 1993
I have now had the response from RTZ - based on the full package that Tony Stapleton brought back with him (my thanks for providing this) which included the key figures on the overall 'cost' of the government package. I am attaching this; Ken Haddow is, incidentally, the RTZ expert on such 'packages'.
The good news is that they seem to like the regulations - which is a relief (since renegotiating the details of 'contracts' is something I have a horror of - it is, in my experience the most unproductive activity any set of managers can waste their time on!).
The bad news is that RTZ see the cost of the total package as being hopelessly uncommercial as it currently stands! If you list the various elements (spread across the two main documents; Mining Income Tax 53/1993 and Mining 52/1993) you find:
1) Tax -
Large Scale mining 45%
(compared with small-scale mining 35%)
2) Tax on Dividends 10%
3) Royalty not yet specified
4) Free Participation 10% (plus unspecified later additions)
This gives an overall total of something in excess of 60-65%. If we assume that royalties are 5% (as they typically are in other African countries) the total rises to 65-70%.
This is, as you will see from their comparison table, in line with other African countries. Unfortunately, it is almost exactly DOUBLE the 35% which the major mining countries (who are not even high-risk countries), with which RTZ does almost all its business, have in their equivalent packages. Indeed, what has emerged in my most recent telephone discussions with RTZ is that the maximum figure they are willing to live with is, under these circumstances unsurprisingly, 35-40% (the latter allowing for the 5% reinvestment allowance - which they do not see as very attractive since it still ties the money up). Needless to say the outcome is that RTZ see little point in even visiting Addis Abeba when the apparent starting point is double this!
The table of comparison is well worth examination - though, in view of its importance (and the possibility that the RTZ figures might be biased), you will obviously want your own experts to check the figures. It shows that African countries are dramatically out of line with the rest of the world - even before allowing for any risk factors! The same point is made by the World Bank Report (no 181) ("...in other mining countries...effective taxation of corporate profits is in the range of 35 to 45 per cent" "higher risk premiums are required [by the corporations]...25 to 30 per cent...as opposed to 20 per cent..."), relevant pages of which I also attach (I will send the whole report and a copy of this fax through the diplomatic bag as usual). They say "...so far Africa has failed to mobilize the necessary risk capital..." The net effect is (according to both RTZ and the World Bank) is that the high tax regimes result in Africa not having its mineral resources developed as they should be. An off the record comment is that those that are being developed are often the province of the less-reputable organisations who on paper accept the 70% figure, but then use questionable accounting (backed by suitable 'donations') to achieve an actual figure of better than 35%. This latter approach can lead to serious distortion of business (and government) practices in those countries; of the sort which I am certain your government would want to avoid!
Assuming these figures are correct, there is no doubt that we are here talking about a commodity market (the output of these mines, indeed, forms a large part of the related global commodities markets) where price is almost all that matters. There is, therefore, no way that Ethiopia can escape this 35% ceiling. Having said all of the above, what can be done to make the figures competitive (without losing credibility)? My suggestions would be:
3) Royalty - as this has not been specified, this can be (contractually) set to zero
4) Participation - again, as this is an option, this can also (contractually) be waived
2) Tax on Dividends - this is reduced to zero in most countries (including in Africa) by 'treaties' with other governments which ensure that dividends are only paid once (in the 'home' country). I imagine that such a treaty could be negotiated with the UK as the RTZ home country.
3) Tax - Large Scale Mining - this is the most difficult. Once again, the definition of what is 'large-scale' is unclear (since it is left to the minister) but it is hard to imagine that RTZ (who are likely to pour in hundreds of millions of dollars eventually) could be described as 'small-scale'! It is not clear, in any case, why this break is there; it certainly does not offer the 'level playing field' RTZ, and other investors, would be looking for (one of its competitors might be able to benefit from a 10% 'subsidy' for doing the same thing as RTZ, but on a slightly smaller scale!). It is difficult to see what the moral justification might be - since the large scale miners would also be contributing massively to development of the infra-structure, where smaller-scale foreign operators would be taking from that infra-structure! As you might have gathered, I think you will need to revisit this position and grade all mining (except artisanal) at 35%.
If you take these decisions then you will be able to achieve 35% overall, which makes you just about competitive with the major countries. Adding in the 5% reinvestment allowance then gives you the slight competitive edge, to balance out the 'high-risk' factors. In the case of RTZ there would also be the added advantages that they recognise the potential, and are keen to do business with a government they feel they can trust. Under these circumstances they admit that they would then see the proposition as very attractive.
I should say that I do not see this as being an initial 'bargaining position' from them; I think it is quite simply the entry price to the negotiations (which probably will not then revolve just around 'price'). Should you feel that you can reach this entry price, then I would suggest that there are a number of major benefits:
a) RAPID VIABILITY - the key conclusion seems to be that without this 'entry' you are almost certainly not going to be able to develop your mineral resources, or at least not at the speed you would wish! With it you may gain benefit in the medium term - even if prospecting starts immediately you must still look to the ten year horizon for major cash-flows - when it will most positively reinforce your main (Agriculture Led Industry) scenario.
b) INFRASTRUCTURE - mining on this large a scale should relatively quickly (mainly medium term, with some short-term) introduce some of the important infra- structure (roads, rail, power) which is missing in the more remote areas (especially Tigray) where these mining developments are likely to take place - with obvious benefits to the rest of the economy
c) VIABILITY OF OTHER LARGE PROJECTS - the problem of the other large projects you are considering is that they need to feed off the 'seed-corn' of comparable major projects. It is especially true of power, where (no matter how cheap) no multinational is going to participate if there are no guaranteed large scale users; your existing small consumers (and the government itself) are simply not seen as a good credit risk! RTZ would, I am certain, justify the entry of a power generator (and, again, with it the infra-structure needed for the rest of the economy).
d) FOREIGN EARNINGS AND EMPLOYMENT - the 'taxes' should not be viewed in isolation. The impact on foreign earnings would be three or four times as great, and the stimulation of the local economy (and the employment of thousands of workers in disadvantaged areas; such as Tigray) would result in major benefits - if it is not allowed to distort the economy (a factor you are already very much in control of). In this context, an apparent difference of 10% in taxes may in practice work out as an overall difference of 2-3%; and can you afford to delay development for such a margin?
This is, clearly, a major strategic decision. My own view would be that (since this sector is only support to the main part of the economy) the most important aspect that you make use of it as soon as possible to 'jump-start' the other developments; and hence work towards the 35%. I would suggest that a good way of examining the issue is to use your experts to try out some alternative scenarios (you already have some very well trained experts in your own ministry!). It might be worth taking the process even further to have the participants role-play the 'actors' in this field (yourselves, RTZ and some less reputable mining conglomerates) - just to get a feel how they might react. I suspect that this process would give you an important advantage in any negotiations with RTZ (who are, remember, used to dealing with much less sophisticated governments in Africa!).
I will try to phone you later this week or early next week to discuss the matter further, before I have another meeting with RTZ, but if you want tg contact me before then please fax me on the above number at any time or phone me at home (as above - 0044 908 679759).
(David Mercer)
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